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Russian Economy: What is Next?

Low crude oil prices negatively impact the economies of oil producing countries. Russia is not exception, and its economy is experiencing an obvious decline. BBC reports:

“Russia’s economy contracted by 3.7% in 2015, according to preliminary figures published by the country’s statistics service.

Retail sales plunged by 10% and capital investment fell by 8.4% in the economy’s worst performance since 2009.

In contrast, Russian GDP increased by 0.6% in 2014.

The economy has been hit hard by the extraordinary collapse in oil prices, which have fallen by 70% in the past 15 months.”

With falling sales and capital investment, the main driver of the economy is direct spending by government, mostly on military projects. Deeper analysis shows that the price of oil is not the only factor causing the decline. There is evidence that the decline is mostly due to structural issues in the economy. Russia has shown signs of recession in 2012 when oil was still $100 per barrel and no economic sanctions were imposed:

“As grim as the numbers are, they may understate the increasingly dismal prospects for a country that only a few years ago was enjoying its greatest prosperity. Economists and business leaders, including some with strong Kremlin ties, are warning that Russia faces long-term stagnation and declining competitiveness. “We find ourselves among the countries that are losing, the downshifting countries,” Herman Gref, head of state-controlled Sberbank, the country’s largest financial institution, said at a conference in Moscow on Jan. 15.

The situation resembles “a staircase leading down,” says Evgeny Gontmakher, a board member at Moscow’s Institute of Contemporary Development, whose chairman is Prime Minister Dmitry Medvedev. Gontmakher predicts Russia will probably eke out near-zero growth through 2017 and that the government will reassure citizens the economy will resume climbing after the March 2018 presidential elections. Instead, he says, the economy “will go downward after 2018.”

Russia has weathered crises before, including a 2008 oil price plunge and a 1998 sovereign debt default. In those cases, robust growth returned within a year or two. This recession’s different, says Vladislav Inozemtsev, a professor at the National Research University Higher School of Economics in Moscow. “It’s not about oil or sanctions; it’s about structural weakness,” he says. There already were signs of malaise in 2012, when oil topped $100 and Western sanctions over Russia’s annexation of Crimea were two years off.

The trigger for the downturn, Inozemtsev says, was Putin’s return to the presidency in May 2012. He raised taxes on business and real estate to finance military spending and expanded the reach of inefficient state-controlled companies such as oil giant Rosneft. “Business people became disillusioned,” curbing investment in factories and equipment, Inozemtsev says. Productivity slackened, corruption thrived, and foreign investment slowed as investors fretted about the state taking over their assets, says Timothy Ash, an emerging-markets strategist at Nomura International in London.

When Putin first became president, in 2000, he said he would reduce the government’s reliance on oil. Instead the government grew even more dependent on oil revenue, and consumer spending became the main driver of the economy.”

There are some optimistic voices. Unfortunately they don’t sound reassuring:

“Russia’s economy has adjusted relatively well to lower oil prices thanks in large part to the ruble, which has tracked oil’s fortunes since 2014. But if oil falls below $30 for an extended period, then all bets are off and Russia’s economy will be in for a prolonged recession.”

This doesn’t really sound like an achievement. Cheaper ruble helps balancing the budget numbers. But cheaper ruble also buys less, impoverishing the ordinary people and putting enormous strain on businesses. I have no doubt that Kremlin kleptocrats are doing great.

“The investment research arm of Sberbank, Russia’s largest lender, warned that if oil does average under a $30 per barrel, then Russia’s budget deficit easily widens to around 3.5 trillion to 3.9 trillion rubles, or around $48.7 billion. Government expenditures are budgeted at around 16 trillion rubles. In a sub-30 oil scenario, the Russian government will be forced to cut its budget by 10% in order to reduce the deficit, according to Sberbank CIB.

Russia’s federal government remains highly solvent.  The country is run by a bend-don’t-break mentality in the economic  policy centers. Western sanctions have helped prolong a recession. Oil just made it worse.

Last year, Russian government accounts declined by around 900 billion rubles. But the Finance Ministry held 250 billion rubles on deposits with banks as of January 1, as well as some more cash not spent in 2015.

Sberbank said they saw “no threats to fiscal stability” this year, as the government has some room to maneuver. Despite the contraction of government accounts heading into 2016, Russia still has nearly $50 billion in its Emergency Reserve Fund and over $70 billion in their National Wealth Fund, a sovereign wealth vehicle used to help Russia’s international firms that have been shut out off low-rate finance in Europe and the United States.”

The mentioned Emergency Reserve Fund provides a cushion, helping plug in holes in the budget, finance military projects and support state owned companies, keeping GDP growing. But it would be more correct to say that Russia has only $50 billion left in its ERF. Most of the money is already spent:

“The country, which has been relying on its sovereign-wealth fund to plug gaps in its budget deficit, said its Reserve Fund is likely to be depleted in 2016. The news is another blow to an economy reeling from weak oil prices and Western-led sanctions in connection with fighting in Ukraine.

“Our reserves volume will decrease by approximately 2.6 trillion rubles ($40.85 billion) — more than half. This means that 2016 is the last year when we are able to spend our reserves that way. After that we will not have such resources,” Russian Finance Minister Anton Siluanov told Tass, the government-owned news agency.”

If oil prices stay low with the same rate of spending, the Emergency Reserve Fund will be totally depleted in one or two years. What’s going to happen then?


See also:

Russia’s Great Shift Downward
Russian economy hit by oil price slide
Sorry Haters, Russia Survives $30 Oil
Weak oil prices deplete Russia’s sovereign-wealth fund